When you talk with the executives of most U.S. companies the subject often turns to the global market and the opportunities for growth that countries like China offer. However, as that conversation continues the next thing you often hear is a deep and abiding concern over the theft of Intellectual Property (IP) that occurs in China.

The ability for most American industries to satisfactorily compete in the global market is mostly based on the strength of their IP. There are two distinct forms of IP—explicit (patent, trademark, copyright, etc.) and tacit (critical information that is not divulged in patents and usually is retained in files or by a few key company employees).

The potential theft of IP presents a serious concern for any company wishing to do business in countries such as China. A recent report by PwC said “the urgent need to protect intellectual property has forced 92 percent of surveyed companies operating in China to plan budget increases on information security in the next 12 months.”

Chinese firms and the government have been under fire for either forcing companies to hand over patents and designs, or acquiring them through other methods, when it comes to products such as high-speed trains, auto designs, mobile phones and wind turbines. The International Intellectual Property Alliance estimates U.S. trade losses due to piracy in China of at least $3.5 billion in 2009.

China presents the fastest growing market in the world. For the coatings industry it is the fastest growing and is the world’s second largest producer and consumer of coatings, and the fourth for ink production. China is the largest coatings market outside of the U.S. Unfortunately it also presents a serious problem that any company attempting to enter into the Chinese market must resolve—protection of technology from theft.

Almost on a daily basis the U.S. news media reports on some nefarious China IP related issue ranging from copyright, trademark or patent infringement. Most of us are aware of the “knock offs” that flood the U.S. market that come from China, including fake designer handbags, watches, apparel and designer sunglasses among others. What we may be less aware of are the counterfeit auto and industrial parts that are now flooding the U.S. market. Although fake consumer items do result in the loss of profit for many American companies, counterfeit auto and industrial parts can cost lives.

The illegal business of stolen IP originates from China’s shaky past. Historically there has been very little if any protection of intellectual property rights (IPR) inside China. In the early days the Chinese were eager to acquire foreign technology and often pursued such desires with an aggressive licensing strategy. There was an incident several years ago reported in the Chinese newspapers whereby one Chinese company had licensed critical technology from a foreign company. The newspaper report read something like the following: “One Chinese company has licensed technology now all Chinese companies have that technology.”

Last March, the United States International Trade Commission banned imports of cast steel railway wheels made by the Chinese group Tianrui. Tianrui had hired nine employees from the Chinese licensee of Amsted Industries of Chicago, a maker of railway parts. They came with an armful of trade secrets that allowed Tianrui to muscle into the business.

This type of intellectual property theft is increasingly common, according to many American companies operating in China. In fact, some companies say, it is tacitly supported by Beijing, and includes forcing foreigners to disclose their technology in order to gain contracts.

China’s attempt to move up the tech ladder is understandable. Many countries in history have pursued technological progress by first trying to piggyback on foreign inventions before blazing their own trails. Still, intellectual property misappropriation through theft cannot be a legitimate government policy goal, especially in a country the size of China, which can and does flood world markets with ill-begotten high-tech products.

For almost 20 years the U.S. and other countries have been aggressively pressing China to improve its intellectual property protection regime. Yet China continues to be the number one source for counterfeit and pirated goods seized at our border, accounting for 79 percent of the total value seized in 2009. The Chinese government itself estimates that counterfeits constitute between 15 and 20 percent of all products made in China and are equivalent to about eight percent of China’s annual gross domestic product. As you can see, this isn’t a trivial matter.

I recall many past negotiations with representatives of the Chinese government whereby they were interested in licensing true state-of-the-art technology. My company’s belief at that time was that the Chinese market for that particular technology was not sufficiently developed and that the best approach would be through the use of some of our older technology. Part of the rationale for our pursuing this “older technology” scenario was based on fear that we would lose our significant technological edge in the marketplace if we licensed our state-of-the-art products to the Chinese. Fortunately for us, at that time, the Chinese market was a nonevent. It was not large, not growing, not a critical market for our eventual success in the global market. Obviously, that situation is not true today for any participant who wishes to be a true global player in the Coatings market. However, even though the Chinese market is very attractive the issue of how to protect your IP has not changed from those earlier days.

It is noteworthy to point out that in the late 70s, early 80s the legal process for both protection and prosecution of IP theft inside China was essentially nonexistent. There have been significant changes, on the surface, to that situation. Unfortunately, most of these changes have been on paper rather than rooted in reality.

Has the Chinese IP theft concerns abated over the years?

The answer to that question is no. It has gotten worse. The combination of deteriorating IP enforcement, domestic protectionism and human resource constraints are restricting the opportunities for foreign companies seeking to compete fairly in China, or so says a recent key business survey conducted by the American Chamber of Commerce in Shanghai.

The annual China business report surveyed 346 American companies operating in China and highlights lingering concerns over issues such as bureaucracy and unclear regulations.

According to this year’s survey, 71 percent of respondents feel enforcement of IPR “stayed the same” or “deteriorated,” up from 61 percent in 2009 and 64 percent in 2008. IP remains a top concern because U.S. companies perceive a lack of protection and enforcement for intellectual property rights to be a blow to their competitive advantage and is costing U.S. companies billions of dollars. The American Chamber of Commerce survey also noted that nearly 80 percent of companies surveyed agree that China’s regulatory environment is not transparent, though China has demonstrated an increased commitment to transparency. Although most American companies who have operations inside China are concerned about IPR issues the opportunities for growth that China represents often overshadow concerns of IP theft.

What does China have in place for the protection of your IP?

Since joining the World Trade Organization (WTO) about ten years ago, China has strengthened its legal framework and amended its IPR and related laws and regulations to comply with the WTO agreement on Traded-Related Aspect of Intellectual Property Rights (TRIPs). Despite stronger statutory protection on paper, China continues to be a haven for counterfeiters and pirates. According to one copyright industry association, the piracy rate remains one of the highest in the world at more than 90 percent and U.S. companies lose over one billion dollars in legitimate business each year to piracy. On average, 20 percent of all consumer products in the Chinese market are likely counterfeit. If a product sells in any part of the world, it is likely to be illegally duplicated inside China. U.S. companies are not alone, as pirates and counterfeiters target both foreign and domestic companies.

Although there appears to be serious commitment on the part of many central government officials to tackle the problem, enforcement measures taken to date have not been effective and have not deterred massive IPR infringements. Chinese leaders talk a good plan but execution often leaves a lot to be desired. There are several factors that undermine enforcement measures, including China’s reliance on administrative instead of criminal measures to combat IPR infringements, corruption and local protectionism at the provincial levels. Chinese mandated policies limit resources and training made available to enforcement officials, and there is a complete lack of public education regarding the economic and social impact of counterfeiting and piracy.

With the advent of the Internet Age we are now seeing an increase in cyber espionage by China. During 2010 Chinese hackers reportedly broke into computers of oil and gas companies in the U.S., Taiwan, Greece and Kazakhstan and stole sensitive information about bidding on oil and gas fields, operations and financing. There have been reported attacks on American financial, oil and chemical industries. Thousands of Chinese computer enthusiasts belong to hacker clubs and security experts say some are supported by China’s military to develop a pool of possible recruits. Experts say military-trained civilian hackers also might work as contractors for companies that want to steal technology or business secrets from rivals.

China has the world’s biggest population of Internet users, with more than 450 million people online, and the Chinese government promotes Web use for business and education. But most experts say security for many computers in China is so poor that they are vulnerable to being taken over and used to hide the source of attacks from elsewhere.

Industrial property rights as defined by the Chinese

There are three kinds of industrial property rights in China, including patent, trademark and copyright.

Patent is composed of “patents for invention,” “patents for utility model” and “patents for design.” A brief summary of China’s patent, trademark and copyright laws are described below.

Patent

China’s first patent law was enacted in 1984 and has been amended three times—1992, 2000 and 2008—to extend the scope of protection. The most recent amendments were made in 2008 (the 2008 Patent Law), and became effective on Oct. 1, 2009. In December 2009, the Supreme People’s Court (SPC), China’s highest court, adopted a set of judicial interpretations regarding cases involving patent disputes (the 2009 Interpretation). In the beginning of 2010, the Implementing Regulations of the PRC Patent Law (the 2010 Implementing Regulations) were amended accordingly to reflect the changes to the 2008 Patent Law. The 2010 Implementing Regulations took effect on Feb. 1, 2010. To comply with TRIPs, the latest amendment extended the duration of patent protection to 20 years from the date of filing a patent application. Chemical and pharmaceutical products, as well as food, beverages, and flavorings are all now patentable. China follows a first to file system for patents, which means patents are granted to those that file first even if the filers are not the original inventors. This system is unlike the U.S., which recognizes the “first to invent” rule, but is consistent with the practice in other parts of the world, including the European Union. As a signatory to the Patent Cooperation Treaty in 1994, China will perform international patent searches and preliminary examinations of patent applications. Under China’s patent law, a foreign patent application files by a person or firm without a business office in China must apply through an authorized patent agent, while initial preparation may be done by anyone. Patents are filed with China’s State Intellectual Property Office (SIPO) in Beijing, while SIPO offices at the provincial and municipal level are responsible for administrative enforcement.

What is the duration of a Chinese patent? The duration of a patent in China for invention is twenty years. The duration of patent for utility model and design is ten years, counted from the application date in China.

What kind of invention cannot be patented in China? According to Article 5 and Article 25 of the China Patent Law, the following items are not patentable in China:

1. Any invention or creation that is contrary to the laws of the state or social morality or that is detrimental to public interest;
2. Scientific discoveries;
3. Rules and methods for mental activities;
4. Methods for the diagnosis or for the treatment of diseases;
5. Animal and plant varieties; and
6. Substances obtained by means of nuclear transformation.
For processes used in producing products referred to in items (4) of the preceding paragraph, patent right may be granted in accordance with the provisions of this Law.

Trademark

China’s trademark law was first adopted in 1982 and subsequently revised in 1993 and 2001. The new trademark law went into effect in October 2001, with implementing regulations taking effect on September 15, 2002. The new trademark law extended registration to collective marks, certification marks and three-dimensional symbols, as required by TRIPs. China joined the Madrid Protocol in 1989, which requires reciprocal trademark registration for member countries, which now include the U.S. China has a ‘first-to register’ system that requires no evidence of prior use or ownership, leaving registration of popular foreign marks open to third party. However, the Chinese Trademark Office has cancelled Chinese trademarks that were unfairly registered by local Chinese agents or customers of foreign companies. Foreign companies seeking to distribute their products in China are advised to register their marks and/or logos with the Trademark Office. Further, any Chinese language translations and appropriate Internet domains should also be registered. As with patent registration, foreign parties must use the services of approved Chinese agents when submitting the trademark application, however foreign attorneys or the Chinese agents may prepare the application. Recent amendments to the Implementing Regulations of the Trademark Law allow local branches or subsidiaries of foreign companies to register trademarks directly without use of a Chinese agent.

Copyright

China’s copyright law was established in 1990 and amended in October 2001. The new implementing rules came into force on September 15, 2002. Unlike the patent and trademark protection, copyrighted works do not require registration for protection. Protection is granted to individuals from countries belonging to the copyright international conventions or bilateral agreements of which China is a member. However, copyright owners may wish to voluntarily register with China’s National Copyright Administration (NCA) to establish evidence of ownership, should enforcement actions become necessary.

Unfair competition

China’s Unfair Competition Law provides some protection for unregistered trademarks, packaging, trade dress and trade secrets. The Fair Trade Bureau, under the State Administration for Industry and Commerce (SAIC) has responsibilities over the interpretation and implementation of the Unfair Competition Law. Protection of company names is also provided by SAIC. According to the TRIPs Agreement, China is required to protect undisclosed information submitted to Chinese agencies in obtaining regulatory approval for pharmaceutical and chemical entities from disclosure or unfair commercial use. China’s State Drug Administration and Ministry of Agriculture oversee the marketing approval of pharmaceuticals and agricultural chemicals, respectively.

What is China’s IPR enforcement system?

In 1998, China established the State Intellectual Property Office (SIPO), with the vision that it would coordinate China’s IP enforcement efforts by merging the patent, trademark and copyright offices under one authority. However, to date this merger has yet to occur. Today, SIPO is responsible for granting patents (national office), registering semiconductor layout designs (national office), and enforcing patents (local SIPO offices), as well as coordinating domestic foreign-related IPR issues involving copyrights, trademarks and patents.

Protection of IP in China follows a two-track system:

• Administrative track, whereby an IP rights holder files a compliant at the local administrative office.
• Judicial track, whereby complaints are filed through the court system. China has established specialized IP panels in its civil court system throughout the country.

Determining which IP agency has jurisdiction over an act of infringement can be confusing. Jurisdiction of IP protection is diffused throughout a number of government agencies and offices, with each typically responsible for the protection afforded by one statute or one specific area of IP-related law. There may be geographical limits or conflicts posed by one administrative agency taking a case, involving piracy or counterfeiting that also occurs in another region. In recognition of these difficulties, some regional IP officials have discussed plans for creating cross-jurisdictional enforcement procedures. China’s courts also have rules regarding jurisdiction over infringing or counterfeit activities, and the scope of potential orders.

Is it possible for the U.S Government to assist you in your IPR infringement cases?

Because intellectual property rights are private rights, the government can provide only limited direct assistance. In many cases, the U.S. Government can provide companies with information in navigating China’s legal system, including lists of local investigative firms and attorneys and share its experience and expertise in China. However, the Department of Commerce cannot provide American companies with legal advice or advocate on a company’s behalf without the company first taking legal action.

When a company encounters blatant infringement of its IPR, the right holder should hire local counsel and pursue a preliminary investigation on one’s own or through a contracted professional firm, keeping in mind that U.S. companies should ensure compliance with Chinese law, which restricts private investigation to certain forms of “market research” investigations. Once the initial investigation is complete, the company should determine if further action and possible costs related with such actions are worth pursuing. Right holders will have the option to initiate actions or seek redress through either the judicial or administrative system. Foreign rights holders have had considerably less success in encouraging criminal prosecution of IPR violations, particularly when copyright infringements are involved.

Once a company decides to pursue a remedy, the Department of Commerce, through their Washington DC or China-based offices will monitor the case, if requested to do so by the company. The U.S. Government cannot intervene in the case; however they can inquire about its status or contact government officials about concerns related to the effective administration of legal remedies available to IP holders. The Department of Commerce is most likely to become involved in a case where evidence indicates China is not complying with its enforcement under the WTO TRIPs Agreement. As with other types of commercial disputes, the government’s efforts in assisting with IPR disputes are aimed at achieving a fair and timely resolution in accordance with international commitments, Chinese laws and in advancing adequate legal and judicial protection for all parties.

Conclusion

If you wish to enter the Chinese market you must ask, “Is China worth the risk?” The Chinese are coming to terms with their past practices of IP theft. Towards the end of last year the city of Los Angeles was actively working with the largest battery producer in China to locate a manufacturing facility in LA. During the negotiations it was discovered that the Chinese producer might not own the technology used to produce the novel lithium-based batteries. As a result the plans were put on hold pending a satisfactory outcome to the ownership situation. As China becomes a more aggressive competitor in the global market they will have to improve on their past practices of turning a blind eye to IP theft.

My advice for anyone wishing to enter into the Chinese market is to thoroughly understand the risk that you are taking not only to your financial investment but to the very life blood of your company, your intellectual property. Include in your due diligence work sufficient time to benchmark with other companies who have preceded you into China, learn from the many companies who have fell victim to the loss of their technology. The Chinese government has recently enacted legislation that makes it more difficult to patent your technology unless it has its origin in China. Make sure you understand your IP rights before you divulge your IP to anyone. Otherwise, you may find that you will be competing against your own technology. Remember, China generally does not protect any IP unless it is registered in China. Though there are a few exceptions to this rule, the bottom line is that it will always be cheaper for a company to register its IP than to litigate, whether it comes within any exception or not. There is a widely believed theory that countries start enforcing IP rights when their more powerful domestic companies demand enforcement because they themselves have IP worthy of protection. Such is the situation in China today.

I remain convinced that China will mend its ways and will realize that to be a member of the global community has certain responsibilities. Unfortunately, China is not at that point today.

Side bar

Administrative Enforcement Action

For administrative enforcement actions, the following is a list of the major players prepared by the U.S. Department of Commerce. This list is not exhaustive, as other agencies, such as State Drug Administration for pharmaceutical counterfeits or the Ministry of Culture for copyright materials and markets may also play a role in the enforcement process. In most cases, administrative agencies cannot award compensation to a rights holder. They can, however, fine the infringer, seize goods or equipment used in manufacturing products, and/or obtain information about the source of goods being distributed. The reader is advised to check closely for possible changes that may have occurred to the various links displayed for each agency.

State Administration on Industry and Commerce (SAIC), Trademark Office

The Trademark Office, under the State Administration on Industry and Commerce (SAIC) maintains authority over trademark registration, administrative recognition of well-known marks, and enforcement of trademark protection. The Fair Trade Bureau handles disputes arising under the Law to Counter Unfair Competition, including trade secret matters. In enforcement efforts, SAIC has the power to investigate the case. When an infringement is determined, SAIC has the power to order that the sale of infringing items cease and to stop further infringement, order the destruction of infringing marks or products, impose fines, and remove machines used to produce counterfeit goods.

At the national level is responsible for the examination of foreign and domestic patents and supervision of local SIPO bureaus. Provincial offices generally handle the administrative enforcement of patent complaints.

Responsible for copyright administration and enforcement. NCA is also responsible for nationwide copyright issues, including investigating infringement cases, administering foreign-related copyright issues, developing foreign-related arbitration rules and supervising administrative authorities. Though administrative remedies are available, NCA generally encourages complainants to use the court system due to lack of personnel.

The Customs Regulations ban the import/export of IPR infringing goods. In order for Customs to exercise this right, the IP holder must record its IP with Customs. The recorded certificate issued by Customs is valid for seven years and is renewable for seven-year periods. When a right holder suspects infringing goods are about to enter or exit China, he/she may submit a written application to Customs at the suspected point of entry or exist where protection is sought. When Customs’ investigation reveals a case of infringement, it has the authority to confiscate the goods, and may destroy or remove the infringing goods, and impose a fine.

Under enforcement provisions of TRIPs, China must provide IP remedies through criminal enforcement for commercial scale piracy and counterfeiting. China’s laws and regulations stipulate that IP administrative authorities and Customs may transfer egregious IP infringement cases to police and prosecutors (procuratorate) for initiating criminal investigation. Despite these criminal provisions, most IP cases continued to be handled through the administrative system. Under Chinese law, individuals also have the right to prosecute criminal cases (zisu), which has rarely been used.

In an attempt to coordinate local IP enforcement efforts, some provinces and municipalities in China have established IPR bureaus or IPR committees to coordinate public awareness campaigns and, to a more limited extent, enforcement. A local IPR bureau is generally a good source for companies seeking information on local regional enforcement mechanisms.

Judicial System

The second track companies can pursue is through civil actions in the local People’s Court. Since 1993, China has maintained Intellectual Property Tribunals in the Intermediate People’s Courts and Higher People’s Courts throughout the countries. The total volume of civil IP litigation in China is considerably less than administrative litigation. Though small companies may prefer to pursue the administrative route, it is expected that the number of IP litigation cases will significantly increase with recent changes in IP laws. Appeals of administrative IPR determinations, such as fines, are generally made to Administrative Tribunals of the Supreme People’s Court (SPC), while the Criminal Tribunals of the SPC are likely to hear criminal cases.